Information Allocation, Private information, Information asymmetry, Disclosures

Private information, Information asymmetry, Information signal, Disclosures

This paper examines why practitioners and researchers get different estimates of equity value when they use a discounted cash flow (CF) model versus a residual income (RI) model. Both models are derived from the same underlying assumption — that price is the present value of expected future net dividends discounted at the cost of equity capital — but in practice and in research they frequently yield different estimates. We argue that the research literature devoted to comparing the accuracy of these two models is misguided; properly implemented, both models yield identical valuations for all firms in all years. We identify how prior research has applied inconsistent assumptions to the two models and show how these seemingly small errors cause surprisingly large differences in the value estimates.

The article investigates how capital markets efficiency is influenced by different information or market structures in the United States. The nature of information regulation depends on the informational efficiency of capital markets. Researchers in accounting and finance have spent considerable effort attempting to measure efficiency. Although this investigation has spanned many research designs and has been applied to many different information signals, empirical tests all suffer from the same basic problem: the benchmark of interest, an informationally efficient market, is unobservable. The asset price that would have prevailed in an efficient market must therefore be modeled, and the test of market efficiency is confounded with a test of the asset-pricing model. Because of this ambiguity, whenever a researcher claims to find an abnormal return based on some information signal another researcher invariably responds that risk was not adequately controlled. The efficiency of a laboratory market can be measured directly by creating another artificial economy that is identical to the economy of interest, except that all information is fully disseminated.

We examine corporate disclosure activity around seasoned equity offerings and its relationship to stock prices. Beginning six months before the offering, our sample issuing firms dramatically increase their disclosure activity, particularly for the categories of disclosure over which firms have the most discretion. The increase is significant after controlling for the firm's current and future earnings performance and tends to be largest for firms with selling shareholders participating in the offering. However, there is no change in the frequency of forward-looking statements prior to the equity offering, something that is expressly discouraged by the securities law. Firms that maintain a consistent level of disclosure experience price increases prior to the offering, and only minor price declines at the offering announcement relative to the control firms, suggesting that disclosure may have reduced the information asymmetry inherent in the offering. Firms that substantially increase their disclosure activity in the six months before the offering also experience price increases prior to the offering relative to the control firms, but suffer much larger price declines at the announcement of their intent to issue equity, suggesting that the disclosure increase may have been used to “hype the stock” and the market may have partially corrected for the earlier price increase. Firms that maintain a consistent disclosure level have no unusual return behavior relative to the control firms subsequent to the announcement, while the firms that “hyped” their stock continue to suffer negative returns, providing further evidence that the increased disclosure activity may have been hype, and suggesting that the hype may have been successful in lowering the firms' cost of equity capital.

Reviews the book "The Value of Communication in Agency Contracts: Theory and Experimental Evidence," by Joyce Berg, Lane Daley, Frank Gigler and Chandra Kanodia.